By Fariborz Moshirian Tuesday 23 June 2015
Photo: Greek prime minister Alexis Tsipras takes part in talks about the country's debt crisis. (Reuters: Alkis Konstantinidis)
The exit of Greece from the Eurozone could potentially cause widespread contagion. That's why we should pay attention to the current negotiations and hope they are successful, writes Fariborz Moshirian.
Last night's meeting between Eurozone finance ministers ended on a positive note for the negotiations between the Greek government and its international creditors. It appears that Greece is now more willing to accept the necessary structural changes to its national budget.
One of the key factors prompting Greece to show more flexibility appears to be the large amount of withdrawals from Greek banks over the past week, over and above the already large sums that had been withdrawn over the past few months. Although these withdrawals did not represent a bank run, it became obvious that if negotiations drag on without progress, Greek banks could become insolvent without ECB support.
The ECB has been carefully watching these negotiations. Greece must repay roughly €3.5 billion to the ECB on July 20. Default could trigger the ECB to cease supporting Greek banks. Without liquidity support from the ECB, capital controls could be imposed, meaning that ordinary people would be unable to access their funds.
Withdrawal of support is a possibility if the ECB deems that Greece is not fulfilling its responsibilities as a member of the Eurozone and not showing flexibility as part of its commitment to the Eurozone. We know from the Cyprus experience that capital controls, once imposed, are slow to be removed.
Regardless of the outcome of the current negotiations, and regardless of whether Greece will be able to manage its roughly €1.6 billion repayment to the IMF due by June 30, Greece will need far more financial support this year and next year. Moreover, the repayment process to the IMF may be difficult, even if the parties settle on an agreement in the next few days.
Although the new economic reform proposal fails to make any major cuts in pension benefits (by the far the most difficult issue between Greece and its international creditors), it includes various revenue-raising measures. Based on reports in the media, including the Financial Times, the proposed new VAT regime will raise €680m this year and €1.36bn next year. The proposed new one-off 12 per cent tax on corporate profits above €500m will raise €945m this year and €405m next year. The proposed new taxes on employers and employees will raise €545m this year and €1.86bn next year.
However, given the fact that Greece is now in recession, its ability to raise tax revenue is reduced. Any forecasts on savings and budget surpluses may therefore not eventuate in the near future. Moreover, the increases in taxes on employers and employees may slow economic growth even more. This would in turn reduce tax revenue and incentives for new investment activities. Another concern is that around €100 billion of private assets, including individual deposits, have left Greece in recent months. This has added to the scepticism over the Greek private sector's ability to invest and flourish.
Despite Greece being a small country with a small economy, there is reason for us all to be attentive to the negotiations currently unfolding. The predicament, if not appropriately managed, may lead to the exit of Greece from the Eurozone - a 'Grexit'.
This is uncharted territory. We do not know what the consequences of a Grexit would look like, and how widespread the contagion may be.
Although European banks, particularly French and German banks, hold less Greek government debt than they did prior to 2012, we cannot underestimate the impact of a Grexit. Prior to the collapse of Lehman Brothers in the US, the market was not overly nervous. However, once it collapsed, havoc was wrought on the markets, and a liquidity crisis ensued. Given the uncertainty, Eurozone authorities including Germany will seek, above all, to minimise the risks of a Grexit, if possible.
Fariborz Moshirian is Professor of Finance and director of the Institute of Global Finance, UNSW Australia.